Prowling Oil Stock Bears Presenting Opportunities

Yesterday, I was buying E&P (exploration and production) stocks as they took a tumble of 2% to 4%. Talking heads are blaming low natural gas prices, which fell 3% yesterday. However, I suspect that the E&P bull market may be over. Most of these stocks barely react to positive news and are significantly weak on negative news. As I warned in the past, the DJIA as the driver of E&P stocks now appears to be failing. It may be a whole new ballgame.

Williston Basin stocks that I bought yesterday are Brigham Exploration (BEXP) at $15.59 and Continental Resources (CLR) at $37.33. I bought natural gas E&P firm Petrohawk (HK) at $19.57. All of three of these are doubling down on positions that I already hold.

Drilling Services Industry: Yesterday, I looked at contract drilling firms, the firms that E&P companies hire to actually drill the wells. This is a very cyclical business.

The demand for drilling rigs today is largely limited to rigs that can drill horizontal wells in shale plays. These “unconventional” rigs are best described as new (or recently rebuilt) big, electric rigs with top drives that are equipped for underbalanced drilling.

Today and for the next few months, at least, unconventional rigs can find work. Conventional rigs are in such oversupply that many of them are idle. Drilling contractors are rapidly converting conventional rigs to become unconventional capable. So the supply of horizontal-capable rigs is increasing.

Yesterday, drilling contractor stocks were in full retreat, I looked at three of them: Helmerich & Payne (HP), market capitalization = $3.8 billion; Pioneer Drilling (PDC), MktCap = $378 million, and tiny Union Drilling (UDRL), MktCap = $134 million. HP and PDC have some international operations, some non-drilling operations, and still have significant number of unconventional rigs. Normally HP is the only of these stocks that I follow.

Union Drilling (UDRL) is tightly focused on the kind of shale plays that I’m interested in. It has no international operations and no non-drilling operations. 55 of its 71 rigs are unconventional rigs. Yesterday in the last five minutes of trading, I tried to buy UDRL at $5.80 but only got a fraction of the shares that I wanted. Union Drilling is very thinly traded; always place a limit order. Had I placed a market order, I easily could have paid $6.20 or much higher for the remaining shares.

Exciting Market Close: E&P stocks vacillated all day but hinted at a buying opportunity. At 3:30 EDT, with only 30 minutes left, the DJIA began sinking, and driving E&P stocks into a panic. What is strange is that the DJIA ended almost unchanged, but E&P stocks were down 2% to 4%, mostly in the last 30 minutes.

By 3:45, several stocks were in my buying range. After that, I was so busy making and modifying orders that I was caught unaware at 4:00 that the market had closed. I made all four of the trades described above in the last 5 minutes of trading.

I made two minor mistakes. I bought twice as much Continental Resources as I had intended to, and I put my Union Drilling order in at 3:58 when it had very little chance of completely filling. Had I stuck to my rule to follow only a few stocks and to focus on only one or two in any given day, I would not have erred. But these are tiny mistakes, and providence always intercedes in my favor.

This is the only excitement that the market has provided in the last two weeks.

Recommendations: I am still 90% in cash. In fact, Wednesday I bought more TIP fund at $103.30; TIP owns treasury inflation protected securities. I am still waiting for a major pullback in E&P stocks and am preserving most of my cash for that. However, I can’t be assured that the pullback will come. Thus I’m making selective investments.

In addition to the stocks that I mentioned above, I’m looking for buying opportunities in Quicksilver (KWK) at $13.50 or lower; it closed at $13.38. Quicksilver is a good (but not great) Barnett Shale natural gas stock. However, its attraction for me is that it also owns large tracts of speculative oil acreage in Western Montana and in the Horn River Basin in NE British Columbia.

Newfield Exploration (NFX) closed at $48.35 only 1.7% above my initial target price to buy at $47.50 (or lower). Although I have concerns about Newfield’s management and its lack of focus, they have a very large undeveloped oil acreage position in the Williston Basin, and large blocks of speculative acreage in Eagle Ford play and in the oil play in Western Montana.

I already hold a bit of Arena Resources (ARD), and will probably double down (buy some more) at $30.80 or lower. Natural gas E&P giant, Chesapeake Energy (CHK) is at it 30, 90, and 180 day lows. The temptation to buy is strong.

I remain gloomy about natural gas. There is so much of it and E&P firms have gotten so good at drilling for it that the current oversupply may last indefinitely. That said, no one is very good at forecasting natural gas prices, either in magnitude or timing.

Philosophy: The trend is not your friend.
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NW Montana’s Southern Alberta-Basin Oil Play: Bakken, Three Forks, Banff (Lodgepole) new play. Updated 17 March 2010

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Location: Northwest Montana: from Cut Bank to the Canadian border and west to Glacier Park.

Major Players:
Rosetta Resources (ROSE) 254,000 net acres, and still leasing
Newfield Exploration (NFX) 221,000 net acres, and still leasing
Quicksilver Resources (KWK) 130,000 net acres (+more in a JV with Mt Power)

We don’t know much, as only three 2010 vertical wells have been drilled (all by Rosetta), and Rosetta tried to complete only one with a horizontal. Rosetta said that three producing zones (Bakken, Three Forks and Banff) taken together are equal to the Williston Basin’s Bakken. That’s a concern as Rosetta’s first attempt to frac all three through one horizontal failed.

This play will likely be slow in developing. Rosetta will only say that it intends to drill at least one well this year and Newfield says they will move a rig in April.

Quicksilver (KWK) looked at the Bakken four years ago with vertical wells on its 130,000 acres, which is held by production. With 2006 technology, Quicksilver found the Bakken to be uneconomic. However with technology’s great leap in 2008 and 2009, its says it will try again. The geology looks good, it only a question of whether 2010 technology fits the local Bakken horizon.

Quicksilver will probably complete or recompleted two horizontal wells in the Bakken in 2010. Quicksilver’s acreage is east of the other operators. The Bakken is only 3,000 to 4,000 feet deep.

Eventually, the Southern Alberta-Basin Oil Play will get developed as technology advances and oil prices increase. Whether it means a major bonanza for any of these, I cannot say.

Assuming all the acreage has equal value, Rosetta is the purer play as its mktcap (market capitalization) is only $1.4 billion. Next is Quicksilver, (mktcap = $2.3 B). And then comes Newfield (mktcap = $7.3 B). Quicksilver the most expertise in horizontal drilling and Newfield is second.

Not of these firms is tightly focused or a pure play. All are natural gas heavy and oil poor.

Recommendation: I’m not hot any of these stocks, especially at current prices. If one has a major decline, I might buy. But, if there is a major pullpack, then other petroleum exploration and production stocks might be even a better buy.
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